Study 3: Dynamics of the Insurance Marketplace Flashcards
Define Commodity (1), and is Insurance considered a commodity? (1)
- A commodity is a product used for commerce.
- Yes, Insurance is a commodity, it is a product traded principally on the basis of price.
What are the main factors that influence the P&C marketplace? (3)
- Marketplace is influenced by individual companies and groups of companies. These entities control new product offerings, capacity (Measure of insurers abilities to issue contracts of insurance), and rates.
- Consumer influences also affect the market.
- Economic influences on the market include increased demands for insurance. (increased activity in the economy creates the need for insurance)
What is economic inflation? (1) and what are the terms economic commentators use to describe the stock market? (2)
-Economic inflation: general increase in the prices of all consumer goods and services. (can lead to higher interest rates)
The two terms used to describe the stock market are:
- Bull market: market is on the rise, strong demand for securities but a weak supply.
- –The economy is strong and employment rate is high.
- –Does well on investment returns
- Bear Market: market in decline, share prices drop and investors believe the downward trend will continue.
- -Investors move investments to safer places (bonds)
- -Economy is sluggish and unemployment rises
Insurance Economics - How do insurance companies differ compared to other companies when it comes to the economy? (4)
- When economy is faltering, insurers have done well, and when its strong, they have done less well. (opposite compared to most other businesses)
- Although government heavily regulates P&C industry, there are few barriers for new entrants into marketplace expect for licensing and capital requirements.
- Insurers work together to accept responsibility for the state of the insurance market, so that Havoc-causing legislative ultimatums can be avoided. (Ex: Mandatory auto insurance)
- Government have imposed sanctions on insurance companies who try to leave a market
What are some causes that can result in reduced profitability to an insurer? (4)
- When Investment portfolios underperform, reduced profitability is the result.
- The cause should be analyzed individually to determine whether poor investment decisions or falling stock prices are the cause.
- Class Action Lawsuits, punitive damages awards, other potential volatile areas of litigation, toxic mold, asbestos, tobacco liability, and cyber risk are all threatening to profitability of insurers.
- Catastrophic losses may cause insurers capacity to erode or make them exit marketplace all together (Ex: Earthquake, terrorist attack)
What may insurers do to try and reduce the effects of non profitable portfolios? (3)
- May write less of a line to protect profitability.
- May exit the marketplace all together (Dramatic natural catastrophes like hurricanes have bankrupt some companies that insure property.
- May simply refuse to renew or write new business in heavily exposed areas.
What happens within an insurance marketplace when one insurance company becomes insolvent? (2)
- There will be one less provider in marketplace, but such an event has a ripple effect on the remaining insurers by shrinking the market and its capacity,
- When one insurer goes bankrupt, each insurer that is a member of the association is called upon to pay its share of claims, this could have negative effect on profit levels of each insurer.
Explain the effects hard and soft markets have on the following groups of people:
- Insurers (2)
- Brokers (2)
- Risk managers (2)
- Consumers (2)
- Governments (2)
Insurers
- -Lose profitability when soft markets take hold. Aggressively look for new business
- -Regain profitability in hard market but face the animosity of brokers and insureds with dramatic price increases
Brokers
- -Enjoy soft markets. Capacity is abundant, premium rates decline, U/W are less demanding. Decline commissions
- -For hard markets, more labour intensive to find capacity for clients. Must negotiate more diligently, commission rise
Risk Managers
- -Soft market benefits them with lower prices, easier underwriting, less demanding loss requirements
- -In hard market, must be more creative in offering options to deal with risk
Consumers
- -Soft markets: they are more neutral with their reaction to the insurance companies
- -Hard markets: they become more wary, distressed and frustrated. Premiums come more unaffordable
Government
–Hard markets: imposes measures they believe will make insurance more affordable. Government backed protection plans: put a cap on the amount of loss. Helps insurers survive a catastrophic event
*Refer to table on pg 3-11 for more info
What are the two different types of market cycles? Compare and contrast them (2)
Soft Market Cycles
- Arise when there is excess financial capacity in the marketplace.
- marketing efforts are intensified in order to gain market share.
- competitive environment drives UW to lower premium rates, relax policy terms, and relax loss prevention and control measures
- New products are created to increase market share
- Underwriting results generally deteriorate and investment environment weakens
Hard Market Cycles
- Rate increases
- Tightened policy terms to limit exposures
- Higher underwriting standards
- Risks are approached more cautiously
- Loss control and loss prevention measures are given more consideratin
- Relationships with brokers with unprofitable results are terminated
- Withdrawal from non-profitable risk and class of business
- Withdrawal from market by selling company to another insurer or placing a run-off (insurance contract stating that the reinsurer remains liable under the ceding company’s policies in force at termination for losses occurring after the date of termination of the reinsurance contract)
What kind of effect can a hard market have on insureds? (1) and how long is a typical insurance cycle? (1)
- Can have detrimental affect on insureds, they may not be able to obtain certain insurance, or may not be able to afford it anymore due to rate increases.
- Life span is typically 7 years (4 years of falling rates will be followed by about 3 years of increasingly weakening results)
What are the major causes that lead to hard markets? (3)
- Limited market competition, can lead to increase in premiums.
- When the Government regulates premium rates, insurers may be unable to achieve premium rates to pay out claims, cover operating expenses, and achieve reasonable profits.
- Demand for a new product grows faster than the number of insurance companies who actually sell it.
Economic forces at work: Explain the supply and demand theory and how it relates to the insurance marketplace. (5)
- Supply represents how much of a product producers are willing to provide at a certain price. (the higher the price, the more the producer would want to supply)
- Demand refers to how much of a product buyers will purchase. (low prices lead to high demand, high prices lead to lower demand)
- Economic theory does not strictly apply to insurance and does not apply to all types of insurance. (Insurance that is mandated by law must be purchased, even if cost is high, an example would be auto insurance)
- Rate peaks and valleys associated with insurance markets are generally caused by capacity (availability) limitations (Problem with supply rather than demand)
- When organic growth becomes almost impossible, an insurer can grow by acquiring other companies (mergers and acquisitions)
Is Canada considered a good place for investors to invest? (3)
- Canada has a reputation for being highly taxed and highly regulated jurisdiction.
- Led investors to believe that this is a place where capital can be tied up.
- Fees and paperwork required to invest in Canada may influence decisions makers to invest elsewhere.
What happens when mandatory auto insurance becomes less accessible to consumers due to higher rates? (4)
- Consumers pressure governments to take action, and in response, the government imposes regulatory sanctions.
- The government has created auto rating board or public utilities commissions to regulate auto premiums.
- This pleases consumers, but from private insurers POV, price regulation is an unnecessary and expensive administrative burden.
- With private auto insurance, there is danger that rates will not accurately reflect claims potential.
What effects can government imposed sanctions have on insurers with regards to mandatory auto insurance? (4)
- Auto insurance accounts for half of the total insurance premium written in Canada, so any regulatory intervention will affect the operations and profits on insurers.
- When a regulator disallows rate increases, or rolls back existing rates, insures may look to reduce internal expenses in order to reduce negative effects.
- Internal expenses that may be reduced include salaries decreases, not paying out bonuses, reduction of staffing, etc. (this can result in loss of quality personnel, poor service, inability to attract new talent)
- Insurers anticipating government imposed reforms but unsure of their effects may consider withdrawing from their jurisdiction, adjusting their marketing plans, or reserving any final decisions until regulators plans are announced.
